How low rates curtail our spending

WASHINGTON — The Federal Reserve’s strategy of holding interest rates near zero to spur the economy is creating a level of uncertainty for American savers that may be softening the policy’s punch.

The central bank has held overnight interest rates near zero since late-2008, and it reiterated on Wednesday that it expects to keep them there through at least the middle of 2015.

Some officials at the central bank wonder if such an unusually prolonged period of low returns on bonds, certificates of deposit and other short-term investments is leading savers to cut back on spending more sharply than they normally would when interest rates drop, undermining the recovery.

“They were counting on getting a certain amount of return from their investments, and consuming based on that,” James Bullard, president of the St. Louis Federal Reserve Bank, told Reuters in a recent interview.

“Since they are not getting it, they have to reduce their consumption, and that seems to be like an effect that isn’t often considered in our macroeconomic models,” said Bullard, who will be a voting member of the Fed’s policy committee in 2013.

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The Fed’s aggressive action to force down borrowing costs is aimed at the high unemployment, depressed home prices and hefty debt levels that are still the central explanations for the reluctance of Americans to spend more aggressively.

But savers are making themselves heard, with politicians speaking up on their behalf as part of a broader election-year attack on the Fed, which has become a lightning rod for Republican anger over government intervention in the economy.

The president of the Dallas Federal Reserve Bank, Richard Fisher, in remarks to reporters earlier this month, worried that low rates were hitting “those that play by the rules, those that save money,” while businesses had yet to step up investment and hiring. Fisher is a long-standing critic of the Fed’s ultra-easy policy.

SAVERS TAKE A HIT

It is clear from government statistics that savers have taken a hit since the Fed dropped overnight interest rates to near zero in December 2008. From the third quarter of 2008 through the second quarter of 2012, personal interest income has plummeted by more than $400 billion to $1.01 trillion.

Retirees and Americans who may be nesting for retirement are a major chunk of the U.S. population, and their spending patterns matter. Thirteen percent, or 40 million people, are over 65, and another 81 million people, or 26 percent of Americans, are aged 45 to 64.

If people believe rates will stay low, it could really change their spending, warned Joe Davis, chief economist at U.S. mutual fund giant Vanguard, adding that the notion of what represents a “normal” bond yield may need to come down.

History offers a reminder that the country has seen prolonged periods of low yields before. Ten-year Treasury yields held in a 2 percent to 3 percent range for decades after 1925 and only hit 4 percent in 1959.

By keeping rates low, the Fed has aimed to support the price of stocks, housing and other assets, which have indeed swung higher.

Fed Chairman Ben Bernanke has acknowledged that savers are being hurt by lower rates, but he has stoutly defended the central bank’s policy as good for all Americans in the long run.

Bernanke has economic theory on his side. Low interest rates are explicitly designed to encourage people to spend, both by lowering the reward for saving and leading to a so-called “wealth effect” that historically has generated greater consumption, growth and hiring.

House prices have recouped most of their losses since the U.S. property bubble burst, although millions of homes are stuck in foreclosure or are valued at less than their outstanding mortgage balances. At the same time, stocks on Wall Street have made a strong recovery. The Standard & Poor’s 500 index has more than doubled from a closing low of 676 on March 9, 2009, adding $7 trillion in market capitalization.

Those gains should be more than enough to offset any spending retrenchment tied to lower returns on fixed income assets. Research shows roughly 10 cents is consumed of every dollar rise in home values, typically a household’s largest asset, although the proportion is lower for other financial assets.

“I understand that people who have most of their income tied up in savings instruments don’t like low interest rates,” said Ami Sufi, a professor at Chicago University’s Booth School of Business. “But the question is, Is that driving the macro-economy? And that is the argument that I find very skeptical.”

Evidence to the contrary would require data showing lower spending among older households. The government does not break down individual consumer’s spending by age group.

Another clue would be an increasing rate of U.S. savings as people borrow and spend less. The saving rate, the proportion of disposable income Americans sock away, has gone up and, at almost 4 percent, is now roughly double its ultra-low level before the recession.

But the saving rate does not look high by historic standards. It ranged between 7.5 and 12.5 percent from 1960 to 1980, when it started to decline.

Surveys, however, suggest Americans approaching retirement have felt pressure to save more. In a poll of pension plan members by consultants Towers Watson, 63 percent of respondents said they need to save much more compared to what they thought three years ago, while 46 percent of older workers said they were postponing retirement.